Time for the investment clock

From ASX

The investment clock, first published in 1937, is a widely used indicator for understanding the movement and conditions of finance, property and sharemarkets. It is thought to take between seven and nine years for the clock to move a full circle.

The current cycle has been so volatile that the clock has arguably moved from 12 (the market high in November 2007) to 7 (falling interest rates) in just 17 months. And deciding where Australia is on the clock is much harder because most asset prices are falling in unison amid global de-leveraging as consumers and companies pay down debt.

With this in mind, ASX Investor Update spoke to six investment experts to obtain their view on the investment clock and provide comments on its merits.

Below is a diagram of the classic investment clock, sourced from Paritech, and the expert commentaries:

Roger Montgomery, chairman, Clime Capital

"Whenever the clock is at 12, investors cannot imagine it will be 6 o'clock again. At 6 o'clock, no one can imagine being at 12. Distance makes the horizon unclear, particularly at ground level, so you get a better view of the future by looking from a higher vantage point.

The investment clock provides as good a compass as any I have seen and it tells you this too will end. At the market peak, just five companies came up as cheap out of the 400 we followed.  That situation continued for such a long time that I started to wonder if something was wrong with the valuation model. But eventually it all turned to pumpkins and mice and now there are more than 200 companies trading below an estimate of intrinsic value.

We will see 12 o'clock again but observers need to understand that the hands do not progress in a nice smooth fashion. Occasionally the hand gets stuck. Each time the clock goes around the story is different but the outcome is the same. The time to be interested in shares is when nobody else is.

Shane Oliver, chief economist, AMP

If I had to pick a time on the investment clock I would say 7.15, given interest rates are still falling. We have obviously had falling share prices and falling commodity prices and we are starting to see falls in real estate values. We expect interest rates to go lower, but it could take some time to move from 7 (falling interest rates) to 8 (rising share prices).

That said, some of the conditions are falling into place for the start of a sustainable recovery later this year and into 2010 - the question is whether the Australian sharemarket has another leg down before that happens. There some signs of stabilisation emerging and Australia's banking system is stronger than most, which means we have a better transmission mechanism to see interest rate cuts get to consumers to stimulate the economy.

Alan Hull, author

First I need to clarify the use of the conventional investment clock that predates the pro-active policies of the US Federal Reserve to combat rising inflation. Hence the clock worked very well when good times led to inflation, which led to rising interest rates and falling asset values.

But alas, that was the conventional reactionary cycle of yesteryear and now we are in a deflationary cycle with falling interest rates, falling asset values and falling everything else (except unemployment, which is rising).

So on that cheery note I will return to my knitting (read: area of expertise) and restrict my comments to the state of global equity markets. And the short answer here is that they are almost fully cooked; that is, I don't think they have much further to fall. But I do expect them to fall a bit further, given that the last phase in a correction is capitulation, which we have not seen yet in my opinion.

Right now, everyone is hoping that the current reporting season will usher in the bottom of the market cycle - capitulation is when no one cares.

But if you were to ask me what the time is, I would say somewhere around 7 o'clock, with 2009 likely to see the clock chime 8.

James Kirby, editor, Eureka Report

If you believed in the investment clock, and I don't, all you would have to do is stop investing at points in the cycle where the numbers don't go your way. Of course, life is not that simple and investment variables do not all move in one direction. Just now, for example, we have falling interest rates but we also have rising share prices ... for gold companies.

More to the point, even if the cycle 'sort of worked' you might grow very old waiting for it to move. To a believer who suggests the clock is now somewhere between 7 o'clock and 8 o'clock (that is, the hand sits somewhere between falling interest rates and rising sharemarkets) I would suggest the clock might just get 'stuck' in that position for an awfully long time.

In early 2009, regardless of the investment clock, we are seeing strong gold prices, good value in bonds, and regular opportunities in selected small-cap stocks and highly selected blue chips. There are also very good opportunities in inner-city, high-yield investment property. Forget about the clock, we don't have time for it.

Greg Hoffman, head of research, Intelligent Investor

"We like stories," explains successful author and trader Nassim Taleb in his book The Black Swan. "We like to summarise and we like to simplify, that is, to reduce the dimension of matters." Taleb describes this as the narrative fallacy and the concept of the investment clock falls into this category for me. Yet its simplicity is matched by its popularity.

Interestingly, I cannot ever recall seeing any commentator put the clock at 12, which, presumably, is the most useful time to recognise.

Another issue is that the clock fuses both economic and investment indicators. The problem with this is that the sharemarket is an anticipatory mechanism, which led to US economist Paul Samuelson's famous quip that 'the sharemarket has forecast nine of the last four recessions'.

In extraordinary times like these it is easy to conclude that the clock is broken. But you only have to cast your mind back to late 2002 to recognise the problems are persistent. Back then, share prices were falling (2 o'clock) and commodity prices were rising (9 o'clock), as were property prices (12 o'clock).

In the clock's defence, it does serve to remind us that there are both up and down cycles. That knowledge is comforting at a time when it is easy to feel as though there is no light at the end of the economic tunnel.

Tony Featherstone, journalist

Relying too heavily on the investment clock to make decisions is, to pardon the pun, cuckoo. Like all models, the investment clock is a shorthand way to help understand the world, in this case market cycles. But no model perfectly fits reality and certainly not the investment clock in such a volatile market, the likes of which have not been seen for decades.

One could make a case that the investment clock could be at 2 (with share prices to make another low), 3 (more commodity price falls as China slows), 6 (heavier property price falls because of rising unemployment) and 7 (more interest rate cuts).

This is the problem with the investment clock: it suggests asset prices and economic variables move neatly from one stage to the next when, in this market, we are seeing de-leveraging worldwide as consumers and companies repay debt and there are falling values across most asset classes.

If I had to name a time, I would say 7.05. Interest rates are falling and more cuts are needed, possibly down to an official cash rate of 2 per cent, to boost the economy. We may see shares start to stage a sustainable recovery late in 2009, although first or second quarter 2010 is looking more likely as global economic data worsens.

How long until we get back to 12? Three to five years, possibly longer, for the Australian sharemarket to eclipse its previous high in November 2007. But there should be reasonable double-digit gains along the way, albeit off a low base. It is going to be a long, hard slog. Decades of too much borrowing and too little saving will take years to fix.

In summary

As one can see, the six experts had different views on the merits and limitations of the investment clock. Most felt Australia was between seven and eight but that it might take time to get back to rising share prices. It was certainly an interesting exercise, so much so that ASX Investor Update will ask experts to "update" the investment clock every quarter. The next reading will be in the June ASX Investor Update.

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